In 2005 the European Union introduced the European Emissions Trading System (EU ETS). This flexible market instrument is the cornerstone of European climate policy. A joint emissions cap was set for participating industrial sectors such as energy companies, oil refineries, blast furnaces and aircraft operators. The cap on available emissions allowances will be lowered gradually in order to reach the European targets (a 21% reduction in emissions by 2020 compared to 2005).
Largest emissions trading system
The EU ETS is the largest greenhouse gas emissions trading system in the world. It regulates the emissions of around 11,000 companies, which are jointly responsible for 45% of European greenhouse gas emissions.
The three trading periods of the EU ETS
The EU ETS is divided into three trading periods.
- Trading period 1: The ‘pre-trading’ phase, which ran from 2005 until the end of 2007. The EU member states were allowed to set the emissions cap themselves.
- Trading period 2: 2008-2012. Non-EU countries Norway, Iceland and Liechtenstein joined the emissions trading system. Starting in 2012, aircraft operators were required to compensate for their emissions by surrendering emissions allowances. The majority of allowances were allocated free of charge to companies during this phase, and a small portion of the total allowances were auctioned.
- Trading period 3: 2013-2020. The European on emissions trade are directly binding and the same for all Member States. As a result, emissions trade is harmonised to a greater degree. Auctioning is becoming an increasingly important way of introducing allowances on the market, as opposed to their free allocation. Companies with a higher risk of moving production activities outside of Europe are allocated a larger number of free allowances. Read more about this topic under Carbon Leakage.
The market mechanism of emissions trade works and the price of emissions allowances responds to demand and supply. However, the price is still too low to act as an incentive for companies to invest in emission reductions. The European Commission has announced various measures intended to reduce the surplus allowances and generate a clearer financial incentive. Read more on this subject under EU ETS Reforms.